General Dynamics is arguably the most investor-conscious company in the defense business. Under the leadership of industry legend Nicholas Chabraja, GD remade itself from a run-of-the-mill military contractor into a consistent earnings performer deploying capital across a diverse portfolio of businesses. Its success in meeting shareholder expectations became a model for other companies in the defense sector, with top executives like Lockheed Martin CEO Robert Stevens expressing admiration for what Chabraja had achieved. As I once observed in Business Week, “Boeing makes planes, Raytheon makes missiles, General Dynamics makes money.”
There was only one problem with the GD model: eventually, Nick Chabraja had to step down. The succession was completed this year, with former Chief of Naval Operations Jay Johnson ascending to the chairman’s job after a highly successful run in several senior executive positions at the biggest energy company in Virginia. Chabraja isn’t gone — he still occupies an influential position on GD’s board — but Johnson is now the public face of General Dynamics. The challenge Jay Johnson faces is that although he is committed to the same investor-centric business strategy that Chabraja championed, he doesn’t yet have his predecessor’s track record of steadily increasing returns to reassure shareholders as the defense sector heads into a downturn.
So far, there’s nothing in Johnson’s tenure at GD to suggest results are going to deteriorate, but that hasn’t stopped some analysts from indulging in gratuitous criticism. For example, one highly regarded analyst suggested investors short GD stock while going long on industry leader Lockheed Martin. No doubt about it, Lockheed Martin is very well positioned for any downturn. However, the company is so broadly invested in defense that it is likely to suffer setbacks in any generalized decline (actually, it already has with the cancellation of the F-22 fighter). GD, in contrast, is more of a niche operation with almost no presence in areas like military aircraft and satellites.
Of course, the GD story with investors has never been about products so much as performance. But if you look at the areas where the company has key franchises, there is a credible case to be made for why it might outperform its peers in the defense sector during a downturn. Exhibit A is its Gulfstream unit, which is the global leader in high-end business jets; Gulfstream provides a good buffer against reverses on the defense side, because its results will improve markedly as the global economy recovers. GD is also the global leader in construction of sophisticated naval surface combatants and nuclear-powered submarines, typically outperforming its main domestic competitor in the shipbuilding arena (which is one reason why Northrop Grumman now wants to exit naval shipbuilding).
GD also outperforms perennial rival BAE Systems in armored vehicles, both at home and abroad. While the combat systems unit in which the company manufactures armored vehicles and munitions is likely to encounter softening demand due to drawdowns in Iraq and Afghanistan, its combination of legacy franchises (Abrams tank, Stryker troop vehicle) and forward-looking opportunities (Expeditionary Fighting Vehicle, Ground Combat Vehicle, Joint Light Tactical Vehicle) provides diverse insurance against major setbacks. And then there is the part of General Dynamics analysts understand least well — Information Systems & Technology. IS&T is very well positioned in cyber security and next-generation tactical communications, so much so that it has become an earnings powerhouse for the company.
GD could probably do a better job of describing to investors what IS&T does, although that isn’t so easy given how many of its programs are secret. But as this brief review of the General Dynamics portfolio reveals, the company faces surprisingly few challenges going forward. Three of the four business units look very strong, and the fourth looks well positioned relative to its competitors despite softening demand. So when you put these properties together with a management that is committed above all else to satisfying shareholders, it seems to be a pretty positive story. Having dealt with GD for 20 years, I can remember other times when investors were inclined to second-guess the company’s management. What I can’t recall is a time when the critics turned out to be right and management turned out to be wrong.
Find Archived Articles: